EU 15 And Ireland

With the reduction of international transaction costs, globalization is dominating the

economic discussion more and more in recent times. Markets that were, measured in

economic distance, far apart only a few years ago are moving together and competition

seems to be tightening. A good case in point is the European Union (EU) with its policy

of creating a common market in Europe.

While the traditionally strong economies such as Germany are facing the competition

mentioned above, the EU has also produced an "infant prodigious". With major investment

and subsidies in infrastructure, development, and education, Ireland and its economy

are performing very well, producing 5.1% real economic growth in 2004, compared

to only 1.7% in Germany.

Of course, the question arises as to how Ireland is able to do that. Somehow the Irish

island seems to be more attractive to economic investment and growth than continental

Europe, or in other words, seems to be more competitive.

This paper introduces the most common instruments to measure a country's competitive

position, discusses their shortcomings, and introduces an extended approach. The findings

are then applied to Ireland.

II. Measuring Competitiveness

The traditional measure for many economies to assess competitiveness, also used in the

EU, is the Real Exchange Rate (RER). The RER measures any given price index at

home against its counterpart abroad and expresses the result in common currency terms.

When deciding on a price index, a commonly used index is unit labor costs (ULC) in

the traded-goods sector of a country. The rationale of this index is simple: since traded

products basically share the same market, comparing the underlying (labor) costs is an

indicator for profitability and, as a consequence, also for the attractiveness of either of

the two economies to produce tradable goods there. In other words, RERULC is a first

indicator for competitiveness of a country.

However, this measurement has some considerable shortcomings. These can be shown

rather intuitively when analyzing various scenarios. In the first scenario, a depreciation

of the domestic currency (given a pricing-to-market strategy of the domestic producers

of tradable goods) increases the profit margin in this sector and hence improves attractiveness

to produce in this sector and country. This is in line with the above findings

since the RER is lowering, indicating an improved competitive position.

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The above discussion can be extended in a first step by introducing the possibility of

price differentiation. After a depreciation of the domestic currency, producers in the

home country will increase their output and lower their prices to sell the increased output.

Hence, value added prices for traded-goods are changing. With RERPVT being the